Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Friday, February 24, 2012

European Federation of Accountants Supports PCAOB’s Reproposed Standard on Communications with Audit Committee

The PCAOB’s reproposed standard on communications with the audit committee introduces enhancements that better enable the audit committee to carry out its monitoring role based on the information received from the auditor, noted the European Federation of Accountants. In a letter to the Board, the Federation emphasized that a fruitful two-way dialogue with the company’s audit committee is an important part of the work of an outside auditor of financial statements, and any initiative to strengthen this cooperation is beneficial to both parties.

The Federation believes that the global alignment of auditing standards to the maximum degree possible is beneficial for capital market participants with cross-border interests. The reproposed standard introduces a closer alignment with the equivalent international audit standards issued by the IAASB, for instance in relation to the emphasis on two-way communication. However, an even closer alignment could further enhance the communication between the two parties.

The use of professional judgment in audits is indispensable, said the federation, enabling the auditor to make informed decisions about the appropriate course of action during the audit. The requirements related to the communication with audit committees in the reproposed standard continue to appear prescriptive and rules-based, although some flexibility has been introduced. Therefore, the risk of limiting the auditor’s ability to exercise professional judgment in deciding on the most appropriate and efficient way of communicating with the audit committee remains.

Although the reproposed standard remains essentially rules-based rather than principles-based, noted the group, quite a lot of guidance and explanation relating to the application of particular requirements is provided in material accompanying the draft standard. The FEE urged the Board to put some of the guidance in the standard itself in order to ensure consistent application of the standard, such as the timing, form, and documentation of communications.

The original proposal included the evaluation of the adequacy of the two-way communication. This particular point is not taken forward in the reproposed standard as the PCAOB considers it duplicative of requirements in other PCAOB standards. Although this may be the case, the Federation believes that the requirement to carry out such evaluation of the adequacy of the communication is an essential part of the quality review of the two-way communication from the viewpoint of the auditor. Thus, the group does not support the proposed deletion, since the auditor should make an assessment of whether improvements to the communication can be introduced to enhance the effectiveness of the audit.

The requirement to disclose details of the composition of the engagement team and others participating in the audit has been expanded compared to the original proposal. While such information could be relevant to disclose to the audit committee, the Federation said that the appropriate balance between useful information and boilerplate disclosure must be found. The Federation supports the proposal, but recommended that the scope of the disclosure be reduced to only significant work performed by another external auditor or a person involved in the audit, and that it not be supplemented by details, such as the percentage of hours. Further, clarification of how the requirement relates to the definition of engagement team is needed to ensure that the disclosures are consistent from one company to another.

The PCAOB is proposing to use the term ``could be substantial doubt’ in relation to going concern evaluations. In contrast, Section 10A of the Securities Exchange Act requires the auditor to perform `` an evaluation of whether there is substantial doubt about the ability of the issuer to continue as a going concern" In the view of the Federation, the proposed PCAOB wording might set too low a threshold. In this context, the PCAOB was urged to use the SEC term of “substantial doubt" or alternatively, include further clarification of what "could" is intended to mean in this context.